Financial Research Journal

Financial Research Journal

The Relationship Between Bank Financing and Market Power: The Role of Bank Liquidity Creation

Document Type : Research Paper

Authors
Hassan Hosseini 1
Maryam Khalili Araghi 2
Ali Namaki 3
Mehdi Madanchi Zaj 4
1 Ph.D. Candidate, Department of Finance, Science & Research Branch, Islamic Azad University, Tehran, Iran.
2 Assistant Prof., Department of Financial Management, Faculty of Management and Economics, Science and Research Branch, Islamic Azad University, Tehran, Iran.
3 Associate Prof., Department of Financial Engineering, Faculty of Accounting and Financial Sciences, College of Management, University of Tehran, Tehran, Iran.
4 Assistant Prof., Department of Financial Management, E-campus Branch, Islamic Azad University, Tehran, Iran
10.22059/frj.2025.381724.1007639
Abstract
Objective
Banks play a fundamental role in promoting economic growth and maintaining financial stability by mobilizing financial resources, allocating credit, and creating liquidity. Their ability to finance economic activities depends on the availability and diversity of financial resources, including customer deposits, borrowing, payment-related resources, and shareholders’ equity. An efficient financing structure not only enhances banks’ lending capacity but also strengthens their ability to create liquidity and compete effectively in financial markets. Market power enables banks to attract a broader customer base, increase their market share, and improve their long-term competitiveness through effective managerial and marketing strategies. At the same time, liquidity creation represents one of the core functions of banking institutions, allowing them to transform relatively illiquid assets into liquid liabilities while facilitating economic transactions and supporting financial intermediation. Although previous studies have extensively examined the relationship between banking activities and various dimensions of risk, comparatively limited attention has been devoted to understanding how financing structure influences market power and how liquidity creation affects this relationship. Therefore, the present study aims to investigate the relationship between bank financing and market power while examining the moderating role of bank liquidity creation in strengthening or weakening this relationship

Methods
The study employs an empirical research design using financial information obtained from 10 banks listed on the Iranian stock exchange during the period from 2015 to 2022. Market power is measured using the Herfindahl–Hirschman Index (HHI), while bank financing is measured through a financing diversification index constructed based on the Herfindahl–Hirschman methodology using the major sources of bank financing. Bank liquidity creation is quantified using a widely accepted liquidity creation index that captures banks' ability to transform financial resources into liquid assets and facilitate financial intermediation. To evaluate the proposed hypotheses, multivariate regression models based on pooled panel data are estimated. Appropriate diagnostic tests are conducted to ensure the validity and reliability of the estimated models and to assess the statistical significance of the relationships among the study variables.

Results
The empirical findings provide evidence of a statistically significant positive relationship between diversified and efficient bank financing and market power. Banks with more diversified financing structures demonstrate stronger competitive positions and greater market power than banks relying on less diversified funding sources. The results further indicate that bank liquidity creation exerts a significant positive moderating effect on this relationship. Specifically, greater liquidity creation strengthens the positive impact of bank financing on market power, suggesting that banks capable of generating higher levels of liquidity are more effective in converting financial resources into competitive advantages. These findings highlight the complementary roles of financing diversification and liquidity creation in enhancing banks’ market positions. The estimated coefficients remain statistically significant across the regression models, confirming the robustness of the empirical evidence and supporting the proposed research hypotheses.

Conclusion
This study contributes to the banking and financial intermediation literature by integrating three important concepts—bank financing, market power, and liquidity creation—within a single analytical framework. Unlike many previous studies that have primarily focused on banking risk or individual aspects of financial performance, this research demonstrates how liquidity creation influences the effectiveness of bank financing in improving market power. The findings provide practical implications for bank managers by emphasizing the importance of diversifying financing sources and strengthening liquidity creation capabilities to improve competitive performance. Furthermore, the results offer useful evidence for financial regulators and policymakers seeking to enhance banking sector efficiency, promote sustainable competition, and strengthen financial stability through policies that encourage sound financing structures and effective liquidity management.
Keywords
Bank financing
Market power
Bank liquidity creation
Lerner
Herfindahl-Hirschman
Multivariate regression
Pooled data
Subjects
 
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Financial Research Journal
Volume 28, Issue 3
2026
Pages 662-692